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Why Facebook Might Start Buying App Developers

I’ve been running a small thought experiment in my head of late and figured I’d write it down. I’ve been wondering whether it makes sense for Facebook to start buying application developers who are building things for their platform. Initially, I felt the answer was a clear “no” but I’ve been moving toward a strong “maybe” of late for the reasons belwo:

Why Might Facebook Want to Buy App Developers?
The first question to ask is whether it makes sense for Facebook to think about buying application developers who are building or have built applications on their platform. I’m of two minds on this. On the one hand, being able to have control over some of the applications with a large footprint in the Facebook user base would give the company the ability to test out some ideas (on both the product and business side) that might not make sense in an arms-length fashion. Locking up some of the most successful application developers and focusing their energy on the Facebook ecosystem would also make life more difficult for the OpenSocial crowd – the folks who are succeeding on social networking platforms today know quite a bit about what it takes to drive viral growth and what new business / marketing / revenue opportunities are beginning to emerge.

How Would Application Developers Respond?
I can imagine two possible responses. One is a moderate revolt among the developer community that Facebook isn’t “playing fair” and isn’t giving the little guy a chance to win. There’s an argument that the average app developer should fear the advantages that captive, in-house applications might have in terms of their access to user data, promotion and marketing, and other factors that lead to success within the Facebook ecosystem. This is a red herring – people are already complaining that successful apps benefit from unequal access to resources at Facebook. Frankly, if I were Facebook I’d make sure I maintained high touch relationships with the best apps on my platform as well – those folks touch a disproportionate number of users.

A second, and I believe more likely scenario, would be one where app developers focus more (as opposed to less) attention on Facebook because selling out to Facebook becomes a real economic option. As OpenSocial starts to take shape as a product offering, more folks will be torn about where to spend their time and energy building these applications. I have to believe there are quite a few investors and company executives who would love to be able to sell their applications to Facebook as an exit opportunity. In the absence of a strong business model that works at scale on the platform, I don’t see what other lucrative options really exist.

Who Would Facebook Buy?
The knee-jerk reaction is to say that Facebook would buy the largest, most successful applications first. Maybe, but not necessarily so. I think there are 3 classes of application developers worth considering

1. People who are really successful on Facebook (or social networks in general, for that matter) today but don’t really have deep investments in destination properties (the social networking only crowd)
2. People who have strong destination sites but do not have top applications on Facebook (we’ll call these guys dabblers)
3. People who are “minor celebrities” on Facebook but are not huge

Buying people in the first category is going to be really expensive. We already have one market transaction that pegs Slide’s valuation in the range of $500 million. I have to believe most of the top application developers (particularly the networks like Slide and RockYou) have high expectations in terms of valuations.

Buying people in the second category is actually a lot more interesting, in my opinion. There are a lot of web 2.0 companies who have succeeded as destination properties or stand-alone services but don’t appear to be terribly reliant on Facebook for user acquisition and growth. Bringing those folks into the Facebook fold could be really huge for Facebook – it would give them some ready-built services and communities that they could figure out how to integrate into the platform. The kinds of companies that fit in this bucket are things like user reviews, games and entertainment, IM, and other categories where people spend a lot of time hanging out and having fun when not on Facebook. As part of Facebook, these sites would have more incentive to spend more time thinking about their Facebook strategies as opposed to just continuing to dabble.

The third category might offer Facebook the opportunity to acq-hire some good developers who might not otherwise want to join a larger company. Google certainly had success with this strategy with a number of its acquisitions. I see no reason why it couldn’t work for Facebook as well.

How would Facebook pay for these acquisitions?
I think this is where the rubber meets the road. I’m not sure that the larger folks on the Facebook platform would want to swap their stock or stock options for Facebook stock at a $15 billion valuation. My sense is there would have to be some cash involved to make these deals work. The good news (if you can call it that, I suppose), is that founder / executive cash-outs are becoming more common in web 2.0 land when larger financings take place. There’s no reason to believe that Facebook couldn’t convince employees and founders to sell to Facebook for deals that are largely stock-based but where individuals are able to take a bit of money off the table at closing if they’d like to do so.

The real rub will be with investors. I don’t know how they would feel exchanging stock in a promising company for stock in Facebook at a $15 billion valuation. For companies that have raised a material amount of money and are doing well, this strikes me as a risky decision and a difficult conversation.

All of these problems might go away if Facebook goes public and the market assigns a value to the business they’re in. Until that happens, it’s going to come down to whether or not people believe there’s meaningful upside on the $15 billion valuation.

What do you think? Feel free to leave comments below.